Lloyds braces itself for downturn

After reporting another record annual profit on Thursday, Lloyds of London is bracing itself for a downturn in the insurance market.

Richard Ward, chief executive, said that in the face of softening premium rates underwriters, must be disciplined in the business they write. He said there were signs that some were cutting capacity, with some of the quoted groups returning surplus capital to shareholders and so removing temptation to chase volume and market share rather than profitable business.

However, he said the market had the financial strength to see it through a more difficult period and was a very different beast to 10 years ago.

He also said the markets exposure to losses from turmoil in the sub-prime market should be small. Luke Savage, finance director, said that after the experience of Enron at the start of the decade, when Lloyds had been hit by high claims, the market now only wrote a fraction of the business in the area that it used to do.

The two men were speaking as the international insurance market reported pre-tax profits of £3.85bn in 2007, up from 2006s record level of £3.66bn.

The exposure to the US mortgage market would be through the casualty segment, which insures risks such as directors liability and professional indemnity. Lloyds said that while the sub-prime issue was a significant one for the insurance industry, Wall Street exposure is no longer as significant as previously and Lloyds is not expected to incur substantial direct sub-prime losses. It would not be until later in 2008 that likely losses could be gauged.

Mr Ward said sub-prime losses experienced by other insurers could be beneficial in improving premium rates, and at the January 1 renewal season there had been some stabilistation of rates in lines of business linked to sub-prime.

He said that in investment terms, Lloyds had no exposure sub-prime assets.

The insurance market benefited from another benign year for catastrophes, although claims were larger at £501m than the £52m of 2006, they were still well below the £3.85bn level of 2005. However, catastrophes were unlikely to remain at a low level.

Lloyds also warned that marine insurance was becoming more important as shipyards around the world were working at full capacity to meet demand for new vessels. However, major hull losses in 2007 were running at levels not experienced since the 1980s. The potential for more frequent losses reinforced the need for discipline in underwriting, Lloyds said.

Aviation was another class of business where losses could increase and after six years of falling rates Lloyds warned premiums could be insufficient to cover these potential increases in loss frequency and severity, let alone any major catastrophe.

It also highlighted the effect price comparison websites were having on motor insurance. Although Lloyds largely avoids the standard car insurance market, the focus on price was adding to extremely competitive conditions.

The motor class suffered the worst combined ratio for the accident year of any of Lloyds classes, with a ratio of 104.8 per cent. A ratio above 100 means an underwriting loss is being made. Only a release from prior year reserves brought the ratio down to 98.4 per cent for the calendar year.

The 2007 results showed a combined ratio across the market of 84 per cent, slightly worse than the 83.1 per cent achieved in 2006. However, for the accident year the combined ratio rose to 90.5 per cent, from 85.2 per cent in 2006, with a 6.5 percentage point benefit from prior year reserve releases. The reserve release amounted to £856m up from £270m in 2006.

Lloyds also benefited from strong investment returns, which rose 21 per cent to £1.22bn. However, with markets volatile the outlook for returns in 2008 was uncertain, it said.